Wall Street Messes Up the EPA’s Sandbox

In his 2006 State of the Union Address, George W. Bush, Jr. announced that America was “addicted to oil” and declared that switching to switchgrass would free the nation of this vice.

It was a pathetic conservative attempt to play catch-up with the Sierra Club and the Washington Post. Bush even recited a shibboleth in the environmental movement, “switchgrass,” an invasive weed that grows just about anywhere and might be harvested and turned into ethanol to run our cars — if anybody could figure out an economical way of doing it.

But economics means nothing in Washington, particularly to a high-minded, save-the-planet bureaucracy such as the Environmental Protection Agency. If economics stands in the way, there is always the magical duo, subsidies and mandates, to overcome it.

And so the Democratic Congress gleefully responded to Bush’s wobbly venture into the world of “renewable energy” by passing the 2007 Energy Security Act, requiring that the oil refineries blend certain quantities of ethanol into their gasoline blends by certain dates. The 2013 mandate was 13.8 billion gallons. At the time, America was consuming 142 billion gallons of gasoline per year and the figure would certainly be climbing higher. It seemed like a suitable goal.

Unfortunately, the housing market melted down in 2008 as the result of another ill-conceived government program and we went into a steep recession. Then we elected a college-Marxist graduate student as President and have sunk into an economic torpor that we probably won’t escape until we elect someone else in 2016 — if then. As a result, America’s gasoline consumption has declined over the last six years. Improvements in gas mileage — mostly impelled by a higher plateau for gas prices — have helped. This year we are projected to consume only 134 billion gallons, down 6 percent from 2007.

But the ethanol mandate has remained at 13.8 billion gallons. Consuming that much will push us over the 10 percent “blend wall” where ethanol begins to harm car engines. Car manufacturers will not honor warrantees on cars that are fueled with more than 10 percent ethanol. Consequently, refiners are stuck with a mandate for buying more ethanol than they use.

But never fear — the EPA had already created a mechanism for greasing the market. Whenever a refiner blends a gallon of ethanol into its gasoline, it receives a 38-digit “Renewable Energy Number” (RIN) that is transferable. The RIN can be sold to other refiners that for some reason are unable to purchase enough ethanol to meet the federal requirements. All this matters quite a bit since refiners that do not meet the EPA quotas can be fined $32,000 a day.

So things stood when the industry ran up against the blend wall this summer. Last January RINs were selling for only 7 cents per gallon. But as it became clear that the mandate was going to push ethanol beyond the blend wall, refiners were suddenly faced with a dilemma. Either they could buy the ethanol and not blend it, stockpiling it for who-knows-what at very high cost. Or they could purchase RINs instead. Suddenly the RINs became a valuable commodity. By summer the price had risen to $1.43 per gallon — expensive but still below the price of buying ethanol and doing nothing with it. Vallero, the nation’s largest oil refiner, estimates buying RINs will cost it $800 million this year.

This value is entirely created by the EPA. Were the Agency to lower the consumption requirement, this artificial value would disappear. As the situation unfolded, tremendous pressure built on the EPA to do just that. So how did the EPA respond? Just as you might expect, it refused to do anything to rescue the situation. Economics, practicality, even the very existence of a mandated commodity mean nothing at the nation’s save-the-planet bureaucracy. Along with the ethanol mandate, the EPA has also been enforcing another 2007 Energy Act provision that says refiners must purchase 250 million gallons of cellulosic ethanol by 2011. Cellulosic ethanol, which is distilled from the non-edible parts of plants, didn’t exist in 2007, doesn’t exist now, and may never exist. Breaking down the cellulose is an extremely difficult process that can be achieved at great expense in the laboratory but has never been done commercially. No matter. The EPA began fining refiners for not buying a product that doesn’t exist. Refineries were docked tens of millions before an appeals court finally stepped in last January and ordered some of the money refunded.

So, as with subprime mortgages and oil price controls and a dozen other attempts to manipulate the market, the government has created an impossible situation that is leading to economic havoc. So who is at fault for all this?

Wall Street!

Well, it’s not entirely fair to say the government has blamed Wall Street. That job has been handled by that arm of the Obama Administration, the New York Times. In a page one story entitled “Wall St. Exploits Ethanol Credits, and Prices Spike,” Gretchen Morgenstern, who usually handles the executives-are-making-too-much-money beat, informed readers that the whole RIN mess is the fault of “traders for big banks and other financial institutions” who have “amassed millions of the credits just as refiners were looking to buy more of them.”

In the case of JPMorgan, the industry executives familiar with the activities in the RINs market said they were told by a top banker in its commodities operation about the stockpiling. The executives said the banker maintained that one of JPMorgan’s traders had urged the bank to buy up every available credit. The executives spoke on the condition of anonymity for fear of harming business relationships.

Somebody’s brother-in-law was probably involved in transmitting this information in a conversation that took place at some end-of-summer party in the Hamptons. But no matter, third-hand rumors are good enough when you’re making a case against “Wall Street speculators.” Anyway, the story is undoubtedly true. Some smart trader saw the whole train wreck coming and bet that the EPA wouldn’t budge. He was right.

The EPA could solve this problem in a minute by lowering the mandate so it wouldn’t exceed the 10 percent blend wall. As Morgenstern had no trouble discovering, however, the EPA is perfectly happy with the mess it has created:

Officials at the E.P.A. do not see excessive influence by financial speculators. They suggest the price spikes in RINs this year reflect the expectation of a shortage of the credits because rising renewable fuel mandates are occurring as consumer demand for gasoline is falling.…

Margo T. Oge, who oversaw the creation of the ethanol credit program at the E.P.A., says the rising price of RINs — no matter the cause — is good news and an indication that the program’s goals are being met. As the credit get more expensive, she says, oil and gas companies have a financial incentive to add more ethanol to fuel rather than buy credits. That, in turn, reduces oil imports and emissions — which was the point of creating the system in the first place.

Never mind that refiners can’t use the ethanol once they buy it. The important thing is to keep us marching toward environmental utopia.

The pattern has become all too familiar. The government cooks up some half-baked scheme of financial incentives that are supposed to move toward an admirable social goal — selling houses to people who can’t afford them, combusting 40 percent of our corn crop in car engines (even though it may be pushing up food prices for undernourished people around the world). When the whole thing blows up, we blame Wall Street for participating in this Rube Goldberg contraption. This then becomes an excuse for more government regulation.

Just last week the Wall Street Journal reported that JPMorgan Chase now has 50 government regulators in permanent residence looking over everybody’s shoulder to make sure things are done the government way. We’re just about at the point of Communist China or the old Soviet Union where there was always a “member of the party” on hand to co-manage every enterprise.

The federal Commodity Futures Trading Commission may expand its look into the role of big Wall Street players in the market for ethanol credits, which soared in price this year, according to a published report.…

That tidbit is just one part of the Times in-depth, 3,200-word story about the market for ethanol credits, a tool the federal government created to help refiners comply with biofuel blending mandates.

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